'This Is What You Want to Own,' Economist Says
This week is going to be all about Hurricane Sandy and reports are already being written about the best ways to "play" the storm. But this too shall (hopefully) pass and the focus will soon return to the biggest issue facing investors: How to find yield in an ultra-low rate environment?
For many individual investors, dividend-paying stocks have been the preferred means to find yield in recent years. Since at least mid-summer, however, there's been chatter about whether this theme is "played out", "overdone" or even entered bubble territory. There are also concerns about dividend stocks getting hit by the fiscal cliff; if Congress doesn't act, dividend taxes (among others) will rise in the New Year.
The iShares Dow Jones Select Dividend Index , a commonly used proxy for the sector, has been underperforming the S&P 500 since early August and trails the index year-to-date as of Friday's close.
But fans of dividend strategies say reports of their demise have been greatly exaggerated.
"The story has got further to run in my opinion in terms of generating good returns for investors in zero-percent interest rate environment," says David Rosenberg, chief economist and strategist at Gluskin Sheff. "They're becoming rich because this is what you want to own in an environment where interest rates are close to zero [but] dividend yields are barely more than 2% — call me when they're 4.5%; dividend payout ratios are 30%, call me when they're 50%."
Of course, not all dividend-paying stocks are created equally. A high dividend yield may be the result of a falling stock price and it usually pays to look for companies with a history of steady payouts vs. "special" dividends.
At Gluskin Sheff, the firm is "much more partial to dividend growth, rather than dividend yield," Peter Mann, a portfolio manager tells me via email. "Even in a yield starved environment, we would rather own a business that can meaningfully grow its dividend off a low base, then own companies that pay it all out just to bribe the shareholder base to stay."
Mann offers the following as examples of the kind of names the firm likes, and is currently long:
Oaktree : We love the management and the large decline that occurred post the IPO, which gave us a chance to get long. Greater than 7% yield with thoughtful guys that walk into burning buildings (on the debt side) while everyone is clamoring to get out. Have earned a performance fee for every quarter for the last 8 years.
Comcast : Operationally as sound a business as we have come across in the current environment. Massive free cash flow growth, dividend growth and large share shrink supplemented by the benefits starting to bear fruit on NBC Universal (which is the parent of CNBC). Small dividend, but with leverage now below 1.4x enterprise value/EBITDA, lots of room to grow it.
ADT Corp : Recently spun out of Tyco International, ADT is the largest U.S. home security provider with 90% recurring (predictable) revenue stream with an average contract of 3.6 years. Customers pay 30 days in advance, supporting all working capital requirements. ADT has 10% free cash flow yield and organic revenue growth of 4-6% with a very under-levered balance sheet (1.3X debt-to-EBITDA) and tremendous opportunity to meaningfully accrete value to shareholders.
For ETF investors, S&P Capital IQ issued a report last week recommending overweight positions in the Utilities Select Sector SPDR , the SPDR S&P Dividend ETF and the iShares High Dividend Equity Fund .
S&P placed "marketweight" recommendations on the DVY, the WisdomTree Dividend ex-Financials Fund and the WisdomTree Equity Income Fund .
"We expect that dividends will continue to have appeal as a form of income, and that corporate America could choose to increasingly utilize cash for special dividends before new tax law goes into effect, or for stock repurchases," the S&P report says.
Aaron Task is the host of The Daily Ticker and Editor-in-Chief of Yahoo! Finance. You can follow him on Twitter at @aarontask or email him at firstname.lastname@example.org
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